India’s tax authorities and the government were pushed on to the backfoot after a row over demands made to several foreign portfolio investors to pay minimum alternate tax (MAT) on their past investments in stocks. This, after the Narendra Modi government’s repeated promises to put an end to what it dubbed as tax terrorism of the UPA government — the retrospective taxation on Vodafone, in particular, had singularly hurt the country’s image as an investment destination.
For now, it appears the damage may be contained, with the Central Board of Direct Taxation clarifying that its field officers will take quick decisions on claims made by foreign funds investing through countries with which India has tax treaties. As Finance Minister Arun Jaitley wrote in an opinion piece in the Financial Times, the government has also decided to form a high-level committee to sort out legacy tax issues to ensure predictability and certainty for investors.
That’s reassuring. But larger questions have been revived, relating to the role of India’s tax department and its consistent failure to provide clarity to foreign and local investors. Several episodes — in the past and over the last few months — also point to a lack of institutional reform in this key arm of the government. This failure has partly to do with successive governments being fiscally imprudent, and thus forcing the taxmen to take recourse to arbitrary tax demands to plug the holes in finances. But as Jaitley himself has admitted in the FT article, the country has not been entirely successful in convincing investors of the fairness of India’s tax system. The big test will be in carrying out reforms in tax administration, therefore, scripted in the past by committees headed by experts like Vijay Kelkar and Parthasarathi Shome.
At a time when investors, local and global, are fretting about a disconnect between pronouncements and action on the ground in India and patience is wearing thin, clarity on policies that impinge crucially on investment decisions, of which taxation is one, is critical. So far, India has had it good with low global crude prices and robust portfolio flows. But a reality check will help. A country that runs a current account deficit and where foreign funds account for 41 per cent of investments in stocks cannot just wish away portfolio investors. That’s where a world-class tax administration, greater clarity on policies, better fiscal management and deepening of the Indian capital markets to ensure a wider base of large local institutional investors should help.
